Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, DLF limited (NSE:DLF) is in debt. But should shareholders worry about its use of debt?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
See our latest analysis for DLF
What is DLF’s debt?
As you can see below, DLF had a debt of ₹39.6 billion in March 2022, up from ₹66.7 billion in the previous year. However, he has ₹11.7 billion in cash to offset this, resulting in a net debt of around ₹27.9 billion.
How strong is DLF’s balance sheet?
The latest balance sheet data shows that DLF had liabilities of ₹104.0 billion due within a year, and liabilities of ₹57.2 billion falling due thereafter. In return, he had ₹11.7 billion in cash and ₹12.5 billion in receivables due within 12 months. It therefore has liabilities totaling ₹137.0 billion more than its cash and short-term receivables, combined.
Given that publicly traded DLF shares are worth a total of ₹747.5 billion, it seems unlikely that this level of liabilities will pose a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
DLF has net debt worth 1.6x EBITDA, which isn’t too much, but its interest coverage looks a little low, with EBIT at just 2.6x interest expense . While these numbers don’t alarm us, it’s worth noting that the cost of corporate debt has a real impact. It should also be noted that DLF has increased its EBIT by a very respectable 22% over the past year, improving its ability to repay its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine DLF’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, DLF has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
The good news is that DLF’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But we have to admit that we find that its interest coverage has the opposite effect. Given all this data, it seems to us that DLF is taking a pretty sensible approach to debt. This means they take on a bit more risk, hoping to increase shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for DLF which you should be aware of before investing here.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.